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LLCS GAIN IN POPULARITY

Victor Elgort, a senior partner at law firm Norris McLaughlin, P.A., started out to be an engineer. But his timing was off. “Astronauts had just landed on the moon,” he recalls. The big excitement was over, a recession was beginning, and, he adds, “I saw that students one and two years ahead of me were having a hard time finding jobs.”

Using analytical skills, Elgort reasoned that the traits that make a good engineer – including analytical skills – are the same abilities that make a good attorney. “You have to break a project down into its parts,” he points out. “There is a systematic application of rules.”

So, leaving his new profession, Elgort, a 1973 Rutgers graduate, packed up and headed to Cornell, where he obtained a law degree, which he later followed up with an advanced degree in tax planning from New York University .

Interesting, the successful practice of engineering or law is not dissimilar to the successful set-up of a new business of any type or size. Analytical skills are essential because there are important choices to be made before a single piece of business takes place. Yet Elgort, who spends many of his days helping to launch companies – or to combine, separate, or expand them – sees that entrepreneurs are often in too great a hurry to make careful choices.

“Everybody is so focused on the need to get up and running that they don’t take the time to think about long term consequences,” he laments. And when problems arise, he adds, “it’s often too late to un-ring the bell.”

One of the first choices an entrepreneur has to make is that of the legal form his business will take. Is it better to make the new venture a corporation or a limited liability company (LLC), or maybe a sole proprietorship? Or does it even matter? Elgort provides insight and advice when he speaks on “Choice of Business Entity in New Jersey : How to Do It Right,” on Thursday, September 18, at 8:30 a.m. at the Best Western Palmer Inn . The cost for this program is $279. For more information, call 800-930-6182.

Business formation is up. Fresh from lay-offs, IT professionals are thinking of starting software development companies and former HR directors are launching corporate training firms. Personal service businesses are shooting up left and right as Boomers delay – or come out of – retirement to put long-deferred entrepreneurial dreams into play. Biotech remains active; restaurants continue to open; and there is no dearth of attorneys and accountants ready to hang their shingles.

No matter what the business, there is an urgency to pin that first dollar to the wall – whether literally or figuratively. Slow down just a little, is Elgort’s advice. Setting up the business properly from the beginning can save untold dollars down the road.

While the possible permutations are endless – “No two businesses are ever the same,” stresses Elgort – there are some guidelines that apply across the board:

Check with your licensing board. Most entrepreneurs are free to make their venture any type of entity they think best. But some are not.

“Professionals are subject to regulations by state or federal agencies,” says Elgort. These agencies establish a list of permissible forms of business entity. “There are 22 or more different regulatory agencies governing licensed professionals,” he says. This situation is in flux, and Elgort sees less restriction in the future, but for now, any professional needs to check with his licensing agency before choosing a business entity.

Look past New Jersey . Elgort recently helped a real estate broker form a business that will have offices in northern New Jersey , southern New York , and eastern Pennsylvania . Each state has different regulations governing the establishment of a real estate company, and the entrepreneur has to conform to all of them.

Think of where your customers are, says Elgort. Think of where your manufacturing facilities are. If your business has tentacles beyond the boundaries of the Garden State , setting up a business entity may involve conformity to more than one set of rules, and the advantages of a particular form of New Jersey business entity may be lessened – or erased altogether.

Take the long view. “When a person is thinking of establishing a business,” says Elgort, “he is focusing on taxes, liability, and insurance.” That is all well and good, but, he asks, “what about asset protection, wealth transfer, bringing children into the business?” In setting up a business, think past the first year or two, and try to consider as many future scenarios as possible.

Give the LLC a good look. The LLC is relatively new. In fact, the first one was formed in New Jersey just about 10 years ago – by Elgort. “It was part of Christie Whitman’s bid to make New Jersey business-friendly,” he says of the legislation that brought the LLC into being.

The legislation passed in the summer of 1993 and went into effect in January of 1994. Elgort attended a ceremony in Trenton to celebrate the state’s first LLC. Elgort will not reveal the name of that first LLC. The business is still his client, and, he says, “I don’t want to be mentioning clients’ names.” He does say, however, that the pioneer LLC is a family-owned business with sales of about $10 to $15 million a year.

In his view, the LLC, which has most of the advantages of a corporation, but is more flexible, and easier to administer, did, in fact, give New Jersey a business edge. In most respects, for most businesses, it is the way to go.

Don’t worry about an LLC’s acceptance. A number of Internet sites that give advice about business formation – and that generally provide the service for a fee – state that an LLC is to be avoided because it is not taken as seriously as a corporation. Banks may hesitate to lend money to an LLC, the online legal advice sites say, and other companies may hesitate to do business with them.

Some of that may have been true years ago, says Elgort, but he is seeing that such fears have largely died down. “At first, banks were worried,” he says. They feared that an LLC would free an entrepreneur of all liability, and that, therefore, they could be left holding the bag in case of a default.

Here again, the online advice sites seem to mislead, stating that LLCs do, in fact, free their owners from liability. This is a common perception among entrepreneurs, says Elgort. And it is wrong. There are a number of reasons for choosing an LLC, but counting on it to act as a shield against all liability is not one of them.

The LLC’s owner is on the hook for any obligation for which he gives his personal guarantee. In the real world, that covers just about everything. Certainly, says Elgort, “banks have the negotiating power to demand a guarantee.” In other words, if a kite shop owner wants a bank loan, he is going to have to sign for it, perhaps pledging his home or his stock account as collateral. Should the kite shop go under, he would be responsible for making good on the loan.

Letting banks know this, says Elgort, was all it took to make them comfortable with LLCs.

The LLC does offer some liability protection, though. Suppliers, says Elgort, may not have the clout to demand a personal guarantee. So, should a business go under, its owner might not be personally liable for business supplies and the like.

Choose a corporation when an IPO is in the future. One of the times when a corporation can be a better choice is the case where a new company is quite sure that it will be going public. Theoretically, an LLC can go public and can issue “units” rather than shares of stock. But, at least for now, potential shareholders are much more comfortable with stock.

When in doubt, go with an LLC. It is easy to convert an LLC to a corporation, and the consequences generally are tax neutral. The converse is not true. When a corporation becomes an LLC, “the tax consequences can be dramatic,” says Elgort. “Essentially,” he says, “you are liquidating the corporation.”

There are often ways to mitigate the tax bite, but doing so takes time and expert advice.

LLCs are now the most popular business choice. Leaving corporations in the dust, LLCs are now the top choice with new New Jersey companies. This is so, says Elgort, because they are so much easier to form and to administer, and because they carry substantial flexibility in taxation. A corporation, for instance, has to have a board of directors, officers, an annual meeting, and bylaws. LLCs need none of these things.

But LLCs are free to adopt any or all of these corporate trappings. They can mimic a corporation in almost any way.

A company of any size can be an LLC. It used to be that many one-person businesses would operate as sole proprietorships, but now, even these very small businesses can reap the advantages of an LLC. There have been a number of amendments to the original LLC legislation. One, in 1998, declared that an individual can own an LLC.

At the other end of the spectrum, says Elgort, an LLC can be a large company with hundreds of millions of dollars in annual sales.

Taxes cut both ways in an LLC. Owners of an LLC can choose to pass-through their business’ net profits – or losses – and figure the tax as they would on personal income. Or, the owners may elect non-pass-through treatment, in which case the tax liability would remain with the entity.

Setting up a business entity is not, in and of itself, difficult or expensive, says Elgort. He cautions, however, that a new business owner consider the choice in a broader context. This is particularly true when more than one person is going to be involved in the enterprise. Issues of management, succession, buy-out rights, and more are best addressed upfront.

A little analytical thinking done in advance, as Elgort’s career path amply demonstrates, can pay outsize dividends for the new entity – whatever its form – for decades to come.

This article was written by Kathleen McGinn Spring and appeared in the September 17, 2003 edition of U.S. 1 Newspaper. All rights reserved. Printed with permission from U.S.1 Newspaper.